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Your Take: Boost Savings Rate by Cutting Taxes

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Actions speak louder than words right? So why is the interest you earn from a savings account taxed at your marginal income tax rate while the dividend income you earn from investments is taxed at the long term capital gains rate? When we put our money in a high interest savings account, the interest we earn is taxed at 25%. When we get a dividend payment, it’s taxed at 15%.

So, if you want people to save more, why not do something simple like tax interest at the long term rate? Or, not tax the first $x,xxx.xx in interest earned each year? It won’t be a perfect answer to our aversion to saving, as interest rates will adjust to the change in tax treatment, but it will certainly change the mindset of your average citizen. Politicians love to talk about how we should be saving more but they don’t actually take any steps to make it a reality (unless you count ignoring the signs of an insanely “frothy” housing market, over-leveraged financial institutions, etc.).

Sadly, given the recession, this will never happen because while we all inherently know that saving for the future is more sustainable than spending it all today, there’s no way a politician can advocate this while we’re in a recession.

Despite that, I’m curious what you think? Crazy idea?

(Photo: gnerk)

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48 Responses to “Your Take: Boost Savings Rate by Cutting Taxes”

  1. Brandon says:

    I thought it would be a good idea to have a company who paid out dividends but solely invested its investments into savings accounts, but then I guessed that corporate taxes and overhead would eat into the small profit margin that would be generated.

    • Nick says:

      Sounds like brokered CDs? I think they aren’t covered by the FDIC. No idea how they’re treated tax-wise.

      • billsnider says:

        Hi

        I have a few brokered CD’s with Fidelity. They are covered by the FDIC up to their usual limits. As to taxes, you pay the usual rates.

        Note that they are not technically CD’s. They sell and are treated like bonds. You buy them in $1,000 denominations.

        They can go bust if the bank does. I had this happen to me. The FDIC paid Fidelity who gave me my money back.

        Note like bonds, some are callable. The bank can cancell them. I had this happen also with a high rate CD. They dropped me like a hotcake when rates went down. Note that when you buy these, the brokerage firm will tell you 1) if they are callable and 2) if they are insured by the FDIC as well as other terms. Helps to get a rating on the bank from Bauer. They give you a free bank ratying and are on the interent.

        Note that the interest rates tend to be lower to cover the brokerage commission. they are good to use if you are pushing around a lot of money and you can’t cover the FDIC insurance from one or two banks.

        You can get more insurance from one bank by having different methods of ownerip. For instance, you are one account, your spouse is another, you jointly are another, you and a child are another and so on.

        Hope this helps.

        Bill Snider

    • Chris says:

      It is a lot of work just to save on your tax margins. Plus it is hard for a business to earn high rates on savings when a consumer can earn much higher rates with products cush as reward checking.

  2. Darin says:

    “So, if you want people to save more”

    They don’t. They want you to spend it all and then more.

  3. I think it may help people like those on this blog that like to already save, but most Americans don’t want to save. Even people who barely make enough to get by, still spend their money on expensive gadgets that they don’t need.

    • Hannah says:

      I agree. Even people who ideally want to save but aren’t proactively doing anything about it probably aren’t stopped by the fact that their interest will be taxed at 25%. I read personal finance blogs religiously and I never even gave a thought to that idea before this post (so good post Jim!).

  4. NateUVM says:

    If you want to make the taxation equal for both types of investment, then I think we should raise the long-term capital gains rate to what everything else is taxed at. These are all forms of income and should be taxed accordingly.

    However, in this period of dis-investment, there is no reason to try and reduce the incentive to invest in equities. While this keeps the status quo in effect, I don’t see any problem with that. If you want the better tax treatment, do “more” for the markets with your money and invest in equities. If you’re going to let it rest relatively idle in a savings account, then your earnings get taxed as income. From that standpoint, it seems fair to me.

    • Chris says:

      An interesting perspecctive. But what about the majority who are uneducated regarding investing?

    • cubiclegeoff says:

      Interesting perspective, and falls into what the country sometimes seems to want, more investment in equities to show that the economy is working. Although more investment in banks in savings account is needed for banks to lend, which the country also wants to happen. So either way, you would seem to be helping the economy. Except overbuying the equities can cause significant problems, while oversaving has its downsides, but I’m not sure if I’d say it causes significant problems.

    • NateUVM says:

      I just feel like the reason that there are different rates is because they want to provide an incentive to hold equities for the long-term, not that it is a specific dis-incentive to deposit in a savings account.

      While I know that others are different, I know that the tax treatment of interest does not keep me from stashing money in the bank.

      • cubiclegeoff says:

        To add to this, maybe they should increase the holding period for dividend stocks before the 15% tax rate comes into play. That would encourage real long-term holding and maybe balance out the stock market a bit.

  5. Chris says:

    If the controlling powers wanted to make things easier, safer, smarter, and more beneficial for the classes below them they would not be a controlling power for much longer. Keep them confused…it keeps the others rich.

  6. Nick says:

    For Massachusetts, you can deduct the first $100 of interest earned at Massachusetts banks.

  7. Shirley says:

    “When we get a dividend payment, it’s taxed at 15%.”

    My IRA monthly distribution holds out 15% for Federal taxes and it has (so far) been enough to cover everything.

    • Jim says:

      That may be true but you’re still being taxed at your marginal tax rate. If your marginal tax rate were 15%, your dividends would be taxed at 0%.

      • Shirley says:

        OK… sounds good to me… :-)

      • Chris says:

        Is this true? If so would the key be to retire with very little cost of living (no mortgage) keep your marginal rate at 15% and have all of your earnings come from dividends?

        • Shirley says:

          That is definitely the way it worked out for us, although I can’t say that keeping our marginal tax rate low was a key part of “the plan”. It just works that way.

          Before I retired we made sure that we had no outstanding debt and could live quite comfortably on the two Social Security checks and a monthly IRA distribution.

          I had 15% of my gross pay going into the IRA and I also rolled over my 27 year employee retirement cash value into it.

          • billsnider says:

            Ditto.

            I did the same. No debt, saved to the hilt and follwed the 100% rule of investing. Helps me to sleep at nights.

            I also rolled my pension over. I didn’t trust the company i worked for. i had two bad prior experiences. Worked out it would have been three if I was still there.

            Bill Snider

  8. cubiclegeoff says:

    I generally agree with Nate, all dividends and savings should be taxed at your marginal tax rate. But it could be an interesting way to get people to save more in this country without needing an economic collapse.

  9. Jessica says:

    The only thing I’ve seen in my lifetime (short as it’s been) that’s largely influenced people in this country to save more (or any) money above what they’d be likely to do with no encouragement is the recession. It already seems like people are already forgetting that saving should still be a priority because we’re “coming out of the recession”. I don’t know if I believe that or not yet.

    Do you pay 15% on dividends even if you don’t have to pay any taxes? Maybe they set the savings interest tax rate to be people’s marginal tax rate so that lower income people would be encouraged to save and earn interest tax free or at a lower tax rate than the divident rate whereas those with higher incomes will be encouraged to spend.

    • Chris says:

      Sad but true. Too many people refuse to make changes and face the truth until something horrible happens, ie. lose their job.

      Like waiting to lose weight until after you have a heart attack, or family reunions after family deaths.

  10. Chuck says:

    Exempting the first N dollars of interest would make it more progressive. It would also make tax filing simpler for those people with less than N of interest income, which would be a good thing, too.

    But then you’d have a disincentive to take that money and invest it in stocks or bonds. Would that be a good thing? Things get pretty complicated when you start screwing with tax policy.

  11. jsbrendog says:

    this is a good idea. It bothers me that I have to claim my ~$50 in interest as income. really?

  12. It’s a genius idea, not because of the practicality of it, but the psychology behind it.

    Honestly, most people earn under a $1,000 in interest off savings accounts, if not under $100 each year. Slashing 10% off their tax bill would amount to a few bucks.

    As with anything though, it’s about marketing. If it were marketed as a decrease in taxes for the common man, then perhaps it would provide a boon to our savings rate. Just like tax deductions do to increase mortgages or charitable contributions.

    I like the idea of exempting the first X dollars ($500? $1,000) in interest each year, then tying it to the capital gains rate. Anything to steer our monetary policy to an element of savings would be great.

  13. Our government’s view on saving was defined well after 9/11, when the Bush Administration encouraged everyone to “go out and shop”. Obama’s message is no different, except this administration has pushed message in a more subtle manor then Bush.

    When you received stimulus money from the government, do you think they hope we would save it? No, because that money is more valuable to them if it is spent. If they truly cared about America’s lack of savings, they would implement a change like Jim has outline. However, it is hard to tell your country to master a skill that you yourself has not yet mastered. Forget savings & surplus, our deficit increased this year by over $1 Trillion dollars to a mind boggling $12+ trillion dollar debt!

  14. Craig says:

    The truth is they don’t want us to save, they want us to spend. Spending drives up the GDP and companies want their numbers to be good so consumers need to spend.

    I’m not saying this isn’t a good idea. I’d love it if I wasn’t taxed on my savings interest earnings.

  15. freeby50 says:

    I think that exempting the first $1000 or so of savings interest from taxes would be a good way to go. That would give people an incentive to save but not go overboard.

    On a side note, a key reason dividend tax rates are lower is the ‘double taxation’ situation for dividends. The corporation paying the dividend gives out dividends after taxes so its already taxed corporate taxes on it then the dividend is distributed to the equity owner who also has to pay taxes on it.

  16. paul says:

    Interesting point… I think the folks most likely to have dividend income are the folks most likely to influence the tax code.

  17. ctreit says:

    @Craig brings up an interesting point. Indeed, the tax code encourages us to spend and not to save. There is no tax on spending except for a state sales tax but no federal VAT.

    As for tax on dividend, we should not forget that dividends are paid from after tax income by a corporation. In other words, any tax we pay on dividend income is paid on income that was already taxed once before. A corporation, in turn, has an incentive to take on debt because the interest payments can be deducted from taxes while dividends cannot be deducted.

  18. bob says:

    You can avoid paying interest on a CD at your federal marginal tax rate by simply placing your CDs in Roth IRAs (better if you are in lower income tax brackets). If you’re in higher tax bracket, place CDs into IRAs (at the same time taking the deduction every year) and take it out in retirement when you are at a lower tax rate. If you feel like you need liquidity, diversify your money between IRAs, Roth IRAs, and tax-efficient investments.

  19. BrianC says:

    I’m not sure it would convince a whole lot of non-savers to start saving. Maybe. But it would certainly be welcomed by the saver crowd.

  20. eric says:

    I wouldn’t mind :)

  21. Darwin Benedict says:

    Being on retirement income, I would like to pull more out of the stock if interest rates were more in a saving account.
    The banking business has all most quit paying interest because there is no advantage for them to do so. Thus people won’t save more. If the Reserve would have a program for banks to earn more I would think it would be passed on. It all depends on how Wall Street would see it.

  22. Safeway_Sage says:

    I guess this is an interesting academic discussion, but I simply don’t put enough in my basic savings account to get hit with a big tax bill! (But I do save) :)

  23. lagreat says:

    Fine article Jim. I beleive even if the tax rate is brought down to 15% like dividend interest it’ll be a win-win for everyone. If I am not mistaken we are the country with that saves the least and such an action by congress will definitely give a boost to personal savings.

  24. thomas says:

    Just like a lot of great ideas for encouraging savings and retirement investment, this one will go bust. gov’t dependence is what those in charge want. no sense in being self sufficient.

  25. MikeB says:

    The government gives me tremendous breaks on my taxes. The two, hobby based, small businesses I run, when I am not at my full time job, provide me lots of tax deductions and has put me into a lower tax bracket. That would help lower the tax on your savings, wouldn’t it?


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